The Big Picture

It took us some time to figure out what and how to invest that met both constraints of our risk tolerances and our current combined income level. But a key missing piece was our retirement goal. I mean, what were we really saving towards? We've been chugging along in "Oh, let's just save this much per month" for too long. It's been bothering me for quite some time. So today I went through a simple Excel exercise in an attempt to paint the big picture. And the initial results are pretty alarming and humbling.

Some important notes and assumptions on the chart:

• The first column on the left of the chart shows my current 401K retirement forecast. For obvious confidentiality reasons the yearly balance is blacked out until my initial forecasted retirement age of 62 (but of course I would like to retire much earlier!). At my age of 62 I have forecasted that we will have ~$2,807,500 based on my current 401K savings rate alone and compounded 8-10% average annual rate of return.
• At age 62 I assume Viks and I will no longer be in the work force and the 401K balance would start to decline from my age 62 and beyond. The decline is determined by subtracting the yearly annual living expense (last column) from the 401K balance at age 62. Despite the yearly decline due to yearly living expenses, I also assume there is a 4% annual return from interest to moderately offset the annual living expenses.
• I was not sure how to factor in long term capital gains tax yet so it is not factored in yet but it would obviously affect yearly 401K balances.
  
• As is today we spend roughly $4500 a month in living expenses with our current mortgage payment, property tax, home + car insurance, food, utilities, gasoline, other, etc.
• Inflation is a painful reality. By my age 62, $4500 in living expenses in 2007 is really $10,923 is year 2037 due to an assumed 3% annual compounded rate. Therefore, the yearly cost of living of $54,000 in 2007 becomes $131,072 in year 2037. Edit: Had a good, long chat with Mr. Eric. He thinks 3% is too aggressive. Obviously if actual inflation is 1%-2%, then you have more money in your pocket. It's easy to go back to the spreadsheet to modify and see how this scenario would affect your monthly retirement expenses.
  
• I am fully aware that our actual annual cost of living from my present age til my age 62 will likely increase (children, bigger house, etc.) but we assume that by my age 62 our living expenses will decrease again and be closer to what we spend today. It other words, our house will hopefully be paid off, children moved out, etc. Instead there will be new types of expenses that will take place of a monthly mortgage ie retirement travel, increased medical expenses?? in addition to usual property tax, food, utilities, etc. My 401K contributions shown in the chart are assumed / forecasted to be UNAFFECTED by events from today to age 62.
  
• To simplify, I did not factor in potential future income that would increase my 401K balance as my thinking is that future expenses (new car, kids, college fund, etc.) will offset the income gain and thus my contributions will likely be in the same neighborhood.
• If I factor in Viks' retirement contributions, the 401K forecasted number would obviously change.
• We are not counting on Social Security in this chart and with the way SS looks today, neither should you.
  

When I first arrived at the number $2,807,500 at age 62 I was thinking, "Hey, pretty cool! We'll be rich!" But from the chart you can see that we'll be broke by my age of 87 due to the annual cost of living at year 2062. If I actually live to age 96 (and Viks age 92), we would need an additional $3,146,101 ! Where would we get that? Go to the next chart below,


So if Viks doesn't add to the retirement account, we'd need to save $2500 (2nd chart) to meet the "Age 87 - 96" deficit as shown in (1st chart). Addendum (1/22) : The first column also assumes 8% average annual rate of return compounded ( which I think is a reasonable market return) in addition to a monthly $2500 after tax savings. I slept on this one and I now think saving $2500 a month for age 87 -96 could be too aggressive depending on how you look at it. One could also try the "save 20% a month" rule of thumb and plug into spreadsheet to see if that meets his/her 401K supplement target. The important thing I am trying to get across is that your 401K may not be enough to last you your lifetime and if you've already exhausted 401K by maxing out and you find that you don't have enough for your monthly expenses in your late, late years other options may be required. Last night, Eric mentioned reverse mortgage as one option.





I've always struggled to articulate my concerns for living in the bay area. If you're still with me so far I did a side-by-side comparison of net savings with two differnt hypothetical mortgage figures in the chart directly above (figures are from realtor.com mortgage calculator).

So for a person or a couple with a HYPOTHETICAL income of $200,000, an $800,000 house with 20% down makes it impossible to buy a new car or pay for the cost of kids if you need to save $2500 a month ( I did not even factor in home insurance costs or other costs like home improvement yet). A $600,000 home is not great but obviously much better in terms of long term savings goals. But in the Bay Area these days, it seems you get very little house (if one at all) for $600,000.


The key take-aways I've come up with so far:
- Time and time again, I have heard advice on how you should save more as well as the question, "are you saving enough?" It took a long time to register for myself, but I finally realized that unless you have some idea of what your goal should be, how can you really save in a meaningful way?

- It's important to get to your personal milestone retirement balance asap and let time & compounding do it's magic. That milestone amount of course depends on your cost of living. And that means really living within your means (unless of course you win the lottery ).

- This next one will undoubtedly be controversial and perhaps I may get flamed for saying this. But I feel that unless you were what I consider fortunate enough to "get in early" or have help from someone it seems you really need to make a lot to live comfortably in the Bay area -and- meet your 401K milestone amount target at the same time. If you find that your monthly mortgage and lifestyle is impeding your 401K milestone target, it probably is a good idea to re-evaluate if you are truly living within your means. Edit: I thought about it some more and I think that while income is certainly an important aspect, it's also important as to how much one actually saves (as I mentioned in first take-away above). Just the other day, a good friend told me that now that he makes more, he finds that he also spends more.

I'm sure there are holes/flaws in my arguments above. Any comments (private/public) are of course welcome.